These ratios and measures assist a company in evaluating its performance regarding the management of the credit function, as reflected in accounts receivable, and also the management of inventory.

Days’ Sales Outstanding

Days’ sales outstanding measures the average number of days that the company is taking to collect accounts receivable from its customers. The formula is:

(Annual Revenue / 365) = (Accounts Receivable / Average Revenue per Day) = Days’ Sales Outstanding

When a company extends credit, it gives its customers the opportunity to pay the company later rather than paying upon receipt of the company’s products or services. Credit terms are provided because giving credit helps to sell product. Extending credit gives the company a competitive advantage (and not doing so would probably put it at a competitive disadvantage).

If average days’ sales outstanding is 43 days, that means that, on average, it is taking that many days to collect owed funds from the customer, from the date of the invoice to the date when the funds are collected. This should be measured against the credit terms of sale. If credit terms are 30 days, a collection period of 40 to 42 days should be perceived as acceptable. Cash sales, if any, should be excluded from the calculation.

Aging of Accounts Receivables

An aging of accounts receivable is a detailed listing of how long the company has been waiting for its customers to pay their bills. Generally, much of the accounts receivable balance will not yet be due, as the amounts will have been billed less than 30 days earlier. A considerable sum might be more than 30 but less than 45 days old, or less than 15 days overdue. The existence of bills more than 45 days old is a sure indicator of customers’ inability or unwillingness to pay or of a feeling on the part of customers that there is no particular pressure to do so.

Receivables Management Can Be Improved

Reducing accounts receivable without jeopardizing sales volume is a very effective way for your company to improve its cash flow. The following list gives basic concepts of credit management that you should consider when you are negotiating with existing and potential customers. Not every idea will work in all situations, and some of these ideas may not be appropriate for your business at all. However, nothing will work if you don’t try it.

1. Be aware that credit is a sales tool. Credit is granted to customers (permitting them to defer payment on merchandise that they already possess and are benefiting from) in order to motivate them to buy and in order to provide an additional competitive advantage. Put credit extension to the test: Will it affect whether or not the customer buys from you? Will it motivate the customer to buy more or buy again? You are entitled to your money. You have earned it; you have spent money to make the sale, and you have provided the customer with the finest product or service of its kind.
2. Never make the extension of credit automatic. Train your sales, service, and delivery people to reinforce your credit strategies.
3. Cheerfully extend credit if the customer asks for it and deserves it. Ask the customer how much time he would like to have. Never extend credit for an automatic 30 or 60 days. Some customers will ask for less credit than you would otherwise have granted. Customers will pay faster in order to maintain credibility with a very important supplier.
4. Train your customers to pay fast. Understanding that old habits die slowly, let the quality of your products and services, rather than your willingness to be a banker, be their motive for buying from you.
5. Get the clock ticking. Agreed-upon credit terms should start the day the product is delivered, not the day the invoice is mailed. Mail out invoices and statements more frequently. This is effective and is rarely noticed. Give the customer the invoice upon delivery, if possible. This reduces mailing expenses and makes the customer even more conscious of the responsibility to pay you fast.
6. Never apologize for asking for your money. You earned it by providing the finest products and services in your marketplace.
7. Search for opportunities to reduce your outstanding receivables. Start slowly, with your new customers and your least desirable existing customers. Train them and those who work for you. Set yourself a six-month target and work toward it. Watch your bank account grow.

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